Lululemon Athletica Q4: Incessant Selling Is Unwarranted (NASDAQ:LULU)

Introduction

The last time I wrote about Lululemon Athletica (NASDAQ:LULU), back in January 2024, I focused on the company’s third-quarter performance and highlighted how the company’s unique strategies, such as its membership program and partnerships, are boosting sales and building a loyal fanbase. I had a BUY rating on the company.

Since my article was published, the stock has slumped 23%, with the majority of these losses coming post the company’s Q4 release. The S&P 500, during the same period, was up 8.8%.

In this article, I discuss the company’s fourth-quarter performance and argue why the recent slump in the stock can be a fantastic buying opportunity for investors with a long-term perspective.

LULU’s Q4 Highlights

LULU finished the fiscal year strongly, with Q4 revenues coming in at $3.21 billion, rising nearly 16% y/y and beating analyst estimates by $8.03 million. Adjusted EPS came in at $5.29, which also surpassed analyst expectations by $0.28. LULU’s gross margins continued to grow strongly, coming in at 59.4%, increasing by 430 bps.

For the full year, net revenues jumped 20% on a constant currency basis to $9.6 billion, and gross margins expanded by 290 bps to 58.3%. Full-year diluted EPS came in at $12.20, jumping 83% y/y. The company, during the year, opened 56 net new stores, ending the year with 711 stores.

For FY24, the guidance remained strong, although it came in lighter than analyst estimates, on account of soft demand in the US. For FY24, the company expects revenues to come in between $10.7 billion and $10.8 billion, falling short of analyst estimates of $11 billion. Full-year EPS is now expected to be in the range between $14 and $14.20, once again falling short of analyst expectations of $14.26.

Lighter-Than-Expected FY24 Guidance Doesn’t Tell the Full Story

Post the earnings release, LULU’s stock tanked nearly 16% and has been on a freefall ever since. In my opinion, if one takes the big picture, then this incessant selloff presents a buying opportunity for the long term.

The primary factor behind the company’s lighter-than-expected guidance is the softness seen in the US, especially during the first quarter. During the earnings call, the company acknowledged that the retail environment in the US has been “somewhat challenging.” However, upon digging further into the management commentary, the main cause of the soft sales in Q1 seems to be that the company has exhausted its inventory, for select sizes and colors, especially among the younger demographics in the US.

As observed from the retail sales data, there is indeed a slowdown in consumer spending in the US. However, based on management’s remarks, from LULU’s perspective, it appears to be a short-term blip rather than long-term structural damage.

Furthermore, the other reason for the softer-than-expected guidance is that the company is planning to make investments to boost brand awareness, which, together with higher depreciation resulting from investments in technology, is contributing to an increase in the full-year SG&A expenses by 130 to 140 bps (1.3%-1.4%). In management’s own words, brand awareness remains “low across most markets,” which the company is now attempting to rectify, to meet the targets set by its Power of Three x 2 strategy. Once again, from a long-term perspective, this is a positive move, in my opinion, one that should aid the company’s growth.

LULU’s China Story Continues to Defy Expectations

A major takeaway from the company’s fourth quarter was the growth seen in China, which has continued to remain impressive. In Q4, the company’s revenue in the region increased a whopping 78% y/y, with comparable sales jumping 60% y/y. The company’s strategy of adopting a localized approach to boosting brand awareness, through community initiatives and by establishing relationships with consumers “through ambassadors, instructors, and influencers,” is most definitely paying off for the company.

Despite the monster growth registered in the region, the company has barely scratched the surface in terms of opportunity. Unaided brand awareness in the region stands only at 14%, and while it represents a marked improvement from the 9% at the start of the year, the region remains significantly underpenetrated for the company, which implies that there is a lot more room to grow for the company in the long-term.

LULU is already making moves to capture this growth opportunity. The company has prioritized customer acquisition and building awareness over operating profits in the region in the near term. Furthermore, the company is allocating a significant portion of its planned 35 to 40 net new stores to the region in 2024. Finally, the company has undertaken several marketing initiatives already in the region, which have been yielding positive results, such as increasing demand for the company’s latest sneaker, Cityverse.

While the company has already defied all expectations in China, especially during a time when the entire region is going through a slowdown, there is still so much more room to grow. The community-based marketing campaigns, which have resonated so well with the consumers in the region, and which are unique to the company itself, should offer a catalyst for the company to significantly capture a bigger portion of the market in the long term.

LULU Loves Innovation & That’s Good for the Long Term

Yet another takeaway from LULU’s Q4 report was the focus that the company continues to place on innovation. A notable example of the company’s ability to innovate was evidenced during the company’s FURTHER event, which began just before International Women’s Day. FURTHER was the company’s first women’s ultramarathon that featured 10 athletes, who are also LULU ambassadors, aiming to run the furthest distances of their careers. As part of the event, the company designed 36 brand-new products, which are set to be introduced in the coming months, with the first of them appearing as early as Q3.

Other products, which are a testament to the company’s innovation, include a hydrogen yarn legging set to be launched in the summer, the Support Code Bra, set to be launched in Q3, and new leggings in the company’s Train segment, which would be launched in the second half of the year. And then in footwear, through innovation, the company entered the men’s footwear category in early February and also recently launched its new road-to-trail running shoe, the Beyondfeel Trail, which has already received positive reviews, especially from a comfort perspective. The company also announced that its Cityverse sneakers have received a strong response from male consumers both in North America and in China, further demonstrating its ability to translate innovation into sales.

The innovation is not coming at the expense of profits. Despite making significant investments toward innovation, LULU’s Q4 gross margins, as mentioned earlier, still came in at an impressive 59.4%. Operating margins also more than doubled y/y, coming in at 28.5%. The strong margins are indicative of a company that is innovating in a disciplined manner.

Valuation

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Source: Company’s Q4 Earnings Release, Seeking Alpha, Refinitiv, and Author’s Calculations

The company currently trades at a forward P/E of 26.3x, according to LSEG Workspace (formerly Refinitiv). Although the company is trading around the same multiple as its peer Nike (23.1x), the company’s growth story has been stronger relative to NKE, in my opinion. Furthermore, the company’s 10-year historical forward P/E has been 31x, which is a more reasonable estimate compared to the company’s 5-year historical forward P/E of 36x, especially since the company is seeing a slowdown in the US. I have, therefore, assumed, 31x as the forward P/E multiple for my calculations.

Management now expects FY24 EPS to come in between $14 and $14.20. Taking into consideration the strong positive response seen for its new products and the fact that one of the main factors driving LULU’s slowdown in the US, especially in Q1, is insufficient inventory, I have assumed that the company will generate $14.20 in FY24, for my calculations.

The forward PEG ratio for LULU, according to Seeking Alpha is 1.74. Assuming a forward P/E ratio of 31x, this would translate to an earnings growth of 18%, which is lower than the company’s trailing 5-year earnings CAGR of 27.2%. However, given the harsh macroenvironment, especially in the US, I have assumed an earnings growth of 18% for my calculations. This translates to FY25 EPS of $16.76.

A forward P/E of 31x and an FY25 EPS of $16.26 results in a price target of $520, which represents an upside of about 39% from current levels.

In my last article on LULU, my price target was $554. Given the weaker-than-expected guidance and given the more challenging macroenvironment that the company is facing in the US, I have assumed a lower P/E multiple (37x vs 31x) and a lower earnings growth (20% vs 18%), which has resulted in a lower price target. My rating on the company, however, has been upgraded to a STRONG BUY.

Risk Factors

One of my risk factors from my last article has already come true. The retail environment in North America has become more promotional and the US consumer, in particular, has been more price-conscious, especially since inflation has remained sticky. This is a risk, which is likely to remain for the foreseeable future.

Then there’s the company’s plans to invest heavily to raise brand awareness, which has already seen an increase in SG&A for FY24. If the company cannot translate the marketing campaign into revenues, and more importantly, profits, then expect the stock to continue falling.

Concluding Thoughts

LULU’s stock has taken a beating since its earnings release, when management announced that it is seeing a slowdown in the US. In my opinion, the selloff in the stock has reached unacceptable levels. The company is ahead of the target it set as part of its Power of Three x2 Strategy and apart from exhausting the inventory in certain sizes and colors, there is nothing to suggest that the company is going to suffer post Q1. The difference between analyst expectations and the midpoint of the company’s guidance is $0.11, and there was nothing to suggest, during the earnings call, that the company cannot maintain its growth story.

Investors were so obsessed with the slowdown in the US that they seem to have overlooked the fact that the company is growing at a breathtaking pace internationally, especially in China. And the company’s ability to innovate has been largely well-received by consumers, as evidenced by the success of Cityverse sneakers. The company is going all-in on raising brand awareness, and it doing this without sacrificing margins. From a valuation perspective, the stock is finally attractive. The incessant selloff, for long-term investors, therefore, is a blessing in disguise in my opinion. Furthermore, based on the company’s track record, I believe that investors writing off this company are missing out on a fantastic opportunity.